Arnold Kling points to labor cost data that he sees as being inconsistent with sticky wage models of the recession. I have a different view of macro than most economists, for instance I’ve often argued that inflation data is basically meaningless, and should be removed from all macro analysis (except perhaps “dorm room” discussions of long run changes in living standards.) Instead NGDP is the nominal variable of interest, and hours worked is the real variable that best picks up the business cycle. Kling’s post looks at the ratio of prices to unit labor costs, a variable that plays no role in my business cycle analysis.

In my view the ratio of wages to NGDP per capita (NGDPPC) is the best way of picking up nominal shocks that might throw the labor market out of equilibrium. Normally these two variables will grow at about the same rate, although there can be gradual changes in the ratio of W/NGDPPC if the share of income going to capital increases, or if the share of total compensation going to non-wage benefits increases.

The St. Louis Fred has wage data only for the period since 2006. Here’s the change in NGDP, NGDPPC, nominal hourly wages, and W/NGDPPC over the past 5 years:

Time period: NGDP growth NGDPPC growth Wage growth W/NGDPPC growth

2006:2-2007:2 4.85% 3.95% 3.72% -0.23%

2007:2-2008:2 3.14% 2.24% 2.92% 0.68%

2008:2-2009:2 -3.90% -4.80% 2.93% 7.73%

2009:2-2010:2 4.43% 3.53% 1.94% -1.61%

2010:2-2011:2 3.77% 2.87% 1.99% -0.68%

This is a very limited sample, but I bet if you went back to 1990 you’d see a similar pattern. During normal times, nominal wages grow at roughly the same rate as NGDPPC, maybe a bit less for the reasons mentioned above. Then from mid-2008 to mid-2009 wages soared relative to NGDPPC. Why did this occur? In my view it happened because the Fed let NGDPPC fall 9% below trend. Nominal wage growth is quite sticky in the short run, so a sudden large change in NGDPPC will usually change the ratio of wages to NGDPPPC, which can be seen as the funds available to pay salaries. If those funds drop sharply, and the hourly wage is stable, the number of hours worked will fall sharply. If the Fed had engineered 3% or 4% NGDPPC growth in 2008-09, nominal wages would still have risen by about 3%, and there would have been far less unemployment.

Since 2009 wages have risen more slowly that NGDPPC, but at current rates it will take years to restore equilibrium in the labor market. One might ask why nominal wages don’t fall quickly to restore equilibrium. Paul Krugman presented data a few months back showing workers rarely receive nominal pay cuts. So in “hard times” you have some workers getting zero raises, and others (in healthy parts of the economy) getting 3% or 4% raises. The average wage increase falls to slightly under 2%.

The last 5 years fit this version of the sticky wage model almost perfectly. If there are other versions of the sticky wage model (perhaps using W/P) that don’t fit the data very well, then perhaps we should consider discarding those non-useful models.

PS. Readers may notice that I estimated NGDPPC simply by subtracting recent US population growth (0.9%) from the NGDP growth numbers. Normally I don’t even talk about NGDPPC, as NGDP is close enough. But for this exercise I thought the per capita numbers would make it easier to see the intuition. NGDP shocks are like a game of musical chairs. Remove 9% of NGDP relative to trend, and you’ll have 9,000,000 unemployed workers sitting on the floor. It’s that simple.

Tags:

This entry was posted on February 21st, 2012
and is filed under Misc..
You can follow any responses to this entry through the RSS 2.0 feed.
You can leave a response or Trackback from your own site.

Does the number of hours worked fall before or after NGDP falls? Isn’t the fall in hours worked itself the falling NGDP, or are these two separate processes?

For example, when you say “NGDP falls,” are you referring to the process when firms experience less demand/sales/orders coming in OR… by “NGDP falls” do you mean that firms are cutting output and price… and then in response to this they realize they must then cut workers/hours.

I apologize if my questions are silly, it is simply that you describe this process in a very abstract sense, and I am trying to SEE with my eyes all these processes occurring in space and time on the ground floor at an actual business. It is difficult to actually visualize what you describe.

Scott,
Kling points out the average mark-up on labor is unprecedented, and he argues that labor demand should be a function of that mark-up. I don’t think you addressed his question.

Perhaps the marginal return to labor, “plays no role in [your] business cycle analysis.” However, it certainly plays a role in a CEO’s decision to expand hiring.

Now, I realize Kling is talking about the average mark-up on labor costs, not the marginal one. Sure, you could claim that CEO faces at terrible marginal return, even though his average return is sky-high. I’m sure Kling would like to hear more about that thesis…

“Normally these two variables will grow at about the same rate, although there can be gradual changes in the ratio of W/NGDPPC if the share of income going to capital increases, or if the share of total compensation going to non-wage benefits increases.”

So if we ignore those “gradual changes” then your *measure* is simply the inverse of per-capita hours worked. So you are saying that if per-capita hours didn’t fall so much, we would have had less unemployment?

But for the rest of us, what he is saying is that since unit labor costs have fallen, firms should be cutting prices. This will increase the real volume of sales and so firms will produce more. (Well, the lower unit cost raise supply, so given demand, firms lower prices and expand production.)

Intead, firms continue to raise prices at an only slightly slower rate. The price level is about 2% below trend, while real GDP is 14% below trend.

Why don’t firms lower their prices and sell more output? Their unit labor costs are lower.

Joe, I’d guess employment lags by a month or two, I believe that’s what the data shows.

Greg, Inflation data is pure garbage. Productivity data is pure garbage. And the ratio of prices to wages divided by productivity is garbage divided by garbage. How am I supposed to respond to that? Even Hayek didn’t think much of price indices and I’d guess you aren’t a fan of “aggregate” productivity numbers. Neither am I. I have no explanation, but it has no bearing on my argument. Kling was the one who seemed to think it had some bearing on my argument.

It would be like me attacking Kling’s recalculation theory by asking: “OK, then explain why we are having such a warm winter!”

David, Ask CEOs why they aren’t hiring workers despite this alleged huge mark-up. Whatever they answer is probably my answer. It has no bearing on my argument. I’d guess they’d say they’d hire more if sales were higher. Suppose the automakers were selling at an annual rate of 17 million units (at current car prices) instead of 13 million, do you think they’d hire more workers? I do. That’s my claim, not enough AD.

DR, You seem to be assuming some statistical regularities that make my theory true. Yes, if you assume all of those things then a fall in NGDP will cause fewer hours worked. But I don’t see why that’s a problem. It goes without saying that I’ve assumed the counterfactual that faster NGDP growth would not have led to faster nominal wage growth, and if you buy my assumption then if the total wage to NGDP ratio stays constant, obviously hours would have been more stable. But there’s no tautology there. If you don’t agree with me I’d think you’d want to argue that faster NGDP growth in 2008-09 merely would have led to faster hourly wage rate increases, not more jobs. That’s obviously possible although I think it’s very unlikely. Or perhaps you don’t think the Fed could affect NGDP. I really don’t see where you are going with this. Maybe someone else can help.

Bill, See my answer to Greg. The CPI says housing costs are up 7.5% in the past 5 years. Case Shiller says they are down by 32%. Which number do you think is more relevant for a home builder thinking of building a new home, and facing sticky construction worker wages? And then recall that housing is 1/3 of the CPI. We need to forget about the CPI and focus on NGDP.

An increase in wages relative to GDP could happen because we are moving along a labor supply curve or because wages are sticky. How do you tell the difference in the data? It doesn’t seem like the above statistics are enough to distinguish between the two possibilities.

Scott,
“Suppose the automakers were selling at an annual rate of 17 million units (at current car prices) instead of 13 million, do you think they’d hire more workers?”

If GM were representative of the economy (had high margins), I would say they could cut prices and move a lot more cars out the door with more labor. Bill Woolsey, above, asks the right question: why don’t profitable firms cut prices to expand and hire?

The high corporate profits to GDP ratio implies that the corporate cost of capital is higher than its ever been, or that firms are earning more economic rent than ever. Either way, the sticky wages thesis does not have much explanatory power over the pace of job creation.

With inflation targeting, every firm is being promised to sell their output at a 2% higher price. Why cut your prices?

But this isn’t a sticky wage argument.

In one of the comments, someone asked what Sumner wants. One of the choices was an increase in per capita labor hours. Of course.

There are lots of arguments about how lower employment raises labor productivity. You stop hiring the low productivity new people. You quit replacing workers when they retire or quit. You lay off the people you probably should have fired.

Now, if you pay the new workers more than they are worth because you expect them to learn something, but you were competing to get them, then when you quit hiring them, unit labor costs fall. There is a sacrifice of future profit. Of course, if you pay them exactly what they are worth now, and then raise their pay when they learn something, unit costs are the same. And if you pay them less than they are worth, unit costs rise.

When you quit replacing workers that retire or quit, and you get the remaining workers to fill in, you can raise productivity. If retiring workers are high pay, and maybe not all that productive right now, this could lower unit costs too.

When you layoff people that you would have liked to fire, unit labor costs fall.

And, of course, we are still trying to raise productivity like usual. And it is possible that the stick of failure is generating more intensified effort along these lines that the more generalized carrot of profit.

Now, with all but this last cause of lower unit costs, as soon as the firms start hiring more, a lot of these factors leading to low unit labor costs go away. You are back to normal.

Yes, productivity is improving at trend. You replace people who retire with low wage newcomers, but they aren’t very productive.

“In one of the comments, someone asked what Sumner wants. One of the choices was an increase in per capita labor hours. Of course.”

That was me. Of course the answer is obvious, based on Scott’s post. The problem is that anything which changes W/NGDPPC might change any of those three. If that is the effect of interest, then how does the Fed increase those per-capita labor hours without decreasing the compensation share of GDP or the wage share of compensation?

And what caused the fall in W/NGDPPC in the first place? Did the Fed cause the compensation share of GDP to rise? The wage share of compensation to rise? How about hours to fall? Is Scott arguing that the Fed caused the fall in in hours, or did something else cause the fall which the Fed should have countered? If the latter, what was the initial shock? If the former, then what happened at the Fed that collapsed hours?

Take a look at “Avearge Hourly Earnings of Production and Non-Supervisory Workers”. That will give you the wage data back to 1964. This was the “headline” wage series that was shown in the monthly employmnet reports prior to 2007. It’s still released every month it’s just that the series that you showed, which is “Average Hourly Earnings of ALL Employees” is now the headline wage series. But the new series only goes back to 2006, as you say. The correlation between these two wages series are very high.

If you use this data you’ll find a similar result to what you have shown above. The correlation betyween the y/y growth rate of the Sumner ratio (NGDP/wage) and the year-to-year chnage in the unemploymnet rate is -0.86 from 1982 to 2011. The correlation is -0.88 is you lag the unemployment rate by one quarter. For the full sample, 1965-2011, the correlation is a still very strong -0.81.

DR, I don’t like the term “resulted in” as it implies causation. I’m certainly not claiming a fall in hours caused the rise in W/NGDP, rather I’m claiming the opposite causation.

But if you are asking which of the three are correlated, my claim is hours worked.

Jason. I agree the data tell is nothing about causation. I was just trying to show to sticky wage skeptics that the data is CONSISTENT with my sticky wage model.

Arnold, Thanks, I left a comment.

DR, Obviously I’d like to see a rise in hours worked.

David. You said;

“Either way, the sticky wages thesis does not have much explanatory power over the pace of job creation.”

You are attacking the wrong sticky wage argument. I agree the traditional textbook sticky wage argument (W/P is too high) may not be consistent with the evidence. But that’s not my argument. You aren’t addressing my claim that if consumers suddenly decides to budget 25% more dollars to car purchases, GM would hire more workers, and not simply raise car prices by 25%. And I think anyone who understands the auto industry would tell you the same thing.

As far as benefits, yes, they are a mitigating factor on the labor share falling since 1980. I doubt, however, that they explain the more recent (2000-2011) fall in labor share, within which the 2008 blip up was just that — a blip.

The data all says the same thing: labor share is low, profits share is high. Average margins are at peak. You can argue the marginal contribution from labor is abysmal when the average contribution is high. Again, that would be an interesting argument to read. What would be the cause of such a steep drop off in the marginal productivity of labor? Could it be structural? Or you could argue, “there is no demand at current prices for the nth high-margin product.” In which case, the issue is not high wages but high prices.

“DR, I’m not claiming the Fed directly caused the fall in hours. I’m saying Fed errors of omission caused NGDP to fall 9% below trend, and since nominal wages are sticky then hours worked fell.”

I don’t follow the connection to W/NGDP. You had written “After 2008 the ratio of W/NGDP rose sharply, creating lots of unemployment.” So maybe you didn’t actually mean that the rise W/NGDP “created” lots of unemployment, but something else?

In any case, I don’t see what you are claiming *DID* cause hours to fall. Yes, I understand that you are arguing the Fed failed to react to something. What was that something?

i am sure sticky wages are a part of the explanation. The longer we go with high unemployment though the more skeptical I become that sticky wages are the lone explanation. first, we have the the issue that using the longer series of production and nonsupervisory employees, average hourly earnings year over year looks to me to drop to about YoY inflation (1.7%, about what you show above). Why not zero? I know at the firm i work for it was zero (actually negative, if you count bonus cuts too). Which brings me to the second issue: variable comp. Companies are wise these days about utilizing variable comp (which for a mid level corporate person might be 30%+ of base) or performance and productivity-based comp (at a steel plant for example). If I did a cross sectional study at a relatively large firm, I would find that the use of variable comp is highly correlated with the cyclicality of the business (e.g. investment bankers get lots of variable comp) as expected – yet front office positions are still eliminated heavily. I also do not see a large differentiation between “right to work” states nd the rest in regards to the speed with which UE drops.

All this adds up to an implausibly large elasticity to me given that we are still at 8.3% unemployment (plus, with the longer series going back to the 90s I see wage growth in the 4% range). I think wages are sticky, just not sticky enough to explain why we are still at 8.3%. Put differently, salaries have already been cut, and the pure sticky wage model says they have not been cut enough.

The other factor is household debt, which is far more rigid IMO than wages (still resetting those mortgage contracts!). For a company like Quiznos or Sears, its no big deal to go into and out of bankruptcy multiple times to abrogate debt contracts, leases, pension and other fixed obligations when revenue drops (in real estate, you are inexperienced if you have not gone through one) and emerge leaner and meaner. If consumers had the same tools to restructure debt available to them that companies do, I predict that recessions would be significantly shorter,

Scott,
Not sure anyone else mentioned this, but you can get better labor data from the BLS and BEA.
On the BLS’s website, you’re right that the headline index goes back to only 2006, but there’s another series that goes back much farther. Weekly hours of production and non-supervisory employees (CES0500000007) goes back to 1964 and the manufacturing version (CES3000000007) goes back to like 1939. Goods-producing industries goes back to 1947.

Also, in the BEA’s PCE data, they have a private wage and compensation series in Table 2.6 going back to 1959 on a monthly basis.

The Fed failed to keep the quantity of money (as measured by labor services) from falling. Or, if you prefer, it failed to increase the quantity of money enough to match the demand to hold money. Or, it failed to increase the quantity of some times of money enough to offset the decerease in other types of money.

Anyway, that is what the Fed failed to do, and the result was a decease in nominal GDP. Oddly enough, simply showing itself unwilling to maintain monetary equilibirum, and so willing to accept a drop in nominal GDP was a large source of the problem. The Divisia measure of money fell largely because the Fed wasn’t willing to keep nomninal GDP on its past growth path, the repurchase aggreement part of the quantity of money fell at least partly because they Fed was not willing to keep nominal GDP on its past growth path.

It was this drop of nomimal GDP from its past growth path that geneated falling sales, reduced prodution, and reduced employment.

Now, all the Fed can do is get nominal GDP back to the past growth path, (or someting in that direction.) I don’t think the Fed should try to prevent the share of compensation in nominal GDP from falling or the share in wages in compensation from falling.

Oddly enough, some of use are thinking about shifting to a target for the growth path of labor compensation. That way, nominal GDP would change with shifts in the labor/capital income shares.

Gadzooks, let’s just try Market Monetarism. Could it be any worse than the directionless mush we get from the Fed now? The Theo-Monetarists and Econo-Shamans chanting verse about inflation? The Gold Nuts?

“I recall reading about opportunistic disinflation in the 1990s, and making a mental note that it was a silly idea, obviously procyclical, and that surely the Fed would not take the idea seriously. Shame on me. The Fed warned us what they planned to do as far back as 1989. We ignored them. Then they went ahead and did it. And they are still doing it. This expansion will have even lower inflation that the last one.”

“I recall reading about opportunistic disinflation in the 1990s, and making a mental note that it was a silly idea, obviously procyclical, and that surely the Fed would not take the idea seriously. Shame on me. The Fed warned us what they planned to do as far back as 1989. We ignored them. Then they went ahead and did it. And they are still doing it. This expansion will have even lower inflation that the last one.”

This chart is supposed to represent the inverse of wage share of GDP. But if you do something simple, like take national income / employee compensation, this interesting pattern goes away. It just bobs up and down between 1.55 and 1.60 between 1997 and 2010.

It’s weird stuff going on with the specific data and adjustment for these calculations. This paper has more detail about those challenges.

“In any case, I don’t see what you are claiming *DID* cause hours to fall. Yes, I understand that you are arguing the Fed failed to react to something. What was that something?”

bill wrote:

“The Fed failed to keep the quantity of money (as measured by labor services) from falling. Or, if you prefer, it failed to increase the quantity of money enough to match the demand to hold money. Or, it failed to increase the quantity of some times of money enough to offset the decerease in other types of money.”

I’d still like to hear from Scott on this, but I don’t see how that answers my question. I understand that Scott’s argument is that they failed. The question is, what did they miss? Did they deliberately ignore some shock? Were they surprised by some shock? What on earth was the shock?

Something put the economy off Scott’s NGDP path. Either the path was deliberate, or the path was a happy side-effect of other policymaking. If the path was deliberate, what caused the Fed to fail at maintaining the path when they’d otherwise done just fine? If the path was just a side-effect, then why did Fed policy suddenly stop producing this side-effect?

Either the Fed failed because they *did something* that caused hours to fall, or they failed because they *did not do something* that would have prevented the fall. I want to know, respectively, what they *did*, or alternately, what required them to *do* something.

Something everyone needs to keep in mind — a useful reminder when monetary minetarists, neo-Keynesians and the rest are engaging macroeconomists who don’t assume that there is not only one kind of thing that changes in liquidity or value or quantity and has money functions, or that there is no structural/value web of changing heterogeneous production processes across time.

Thanks. I do have my own view, which is unimportant for the moment. I’m really interested in eliciting Scott’s view. I don’t really understand where he is coming from, apart from the fact of failure at the Fed.

David, You just keep throwing misleading graphs at me, you need to think before posting. What’s that seeking alpha graph supposed to show? And the next graph as well? I stand by my comment, the first graph you showed me was completely false data. The other two show nothing of interest.

Furthermore, your profits graphs conflict with your wage graphs; are you even seriously looking at the actual numbers, or just whether lines seem to go up or down?

DR, You said;

“OK. So you want to lower W/NGDPPC by increasing hours worked. How do you increase hours without inducing a corresponding fall in compensation share of GDP or wage share of compensation?”

I think you are misinterpreting the ratio. It’s not the ratio of wages to NGDPPC, it’s the ratio of hourly wages to NGDPPC. That’s very different. If hours rise you can have more wages as a share of NGDPPC.

Put the two together and you get low but positive wage increases on average. That’s the way the world works–if it doesn’t seem to fit theory, change the theory.

I think you are focusing too much on wages. The problem is too little NGDP, not too little wage flexibility. Wages are inflexible. It’s like blaming a bridge collapse of gravity. Gravity exists, so does wage stickiness. You work around it.

DR. I am claiming that when the Fed lets W/NGDPPC fall suddenly you get higher unemployment. The mechanism is a lack of nominal expenditure to support the current workforce.

David, Still another graph that has no bearing on this post. The wage share of GDP is not a factor in the business cycle.

Gregor, Interesting.

John Hall, Does it show similar rates or wage gains?

Morgan, I agree they are likely to go for 4.5% going forward, my point was that it was closer to 5% after 2000.

[…] wish to put words in his mouth but that is how it sounds to me. Maybe I am so blinded by the NGDP targeting story that I overestimate the amount of slack in the economy, the size of the output gap, the flatness of […]

Major, Your answer makes no sense. Do sticky wages cause unemployment or not? You seem to suggest it does, but they deserve it. But individual workers don’t control their wages, they are set by larger institutions.

Major, Your answer makes no sense. Do sticky wages cause unemployment or not? You seem to suggest it does, but they deserve it.

Not in the slightest. Please try to address what I am saying, rather than what I am not saying. I have made it clear that minimum wage laws, unemployment insurance, and inflation psychology, among other government interventions, are NOT the fault of wage earners.

But individual workers don’t control their wages, they are set by larger institutions.

And the penny drops. You believe in the fallacy of “administered” prices. No, larger institutions do not “set” wages. Wages are negotiated between two parties, those who pay wages and those who receive wages. A wage earner can outcompete other wage earners by asking a lower price, and in a free labor market, wage rates can fall to whatever level clears the market. If labor is currently overpriced, then in a free labor market is the best solution to solve it. Those who best know their own conditions and the market conditions, can set new prices for their exchanges.

Those workers who REFUSE to lower their wages, are not showing the problem of a free labor market, they are just being stubborn, the same way a seller of rotary phones would be stubborn to keep his prices high in the face of new market conditions that contain cell phones.

Major. No, if a perfectly qualified worker walks up to an auto facotory and offers to work for 20% less, they won’t fire a existing worker and hitre this guy, even if just as good.

That’s because of coercive labor union power through the state. The union can lobby the state to attack the employer for “not bargaining in good faith.” That is not a free market “inefficiency.”

Furthermore, employers typically anticipate what market wages will be, so that if there are cases of potential workers offering their labor for a lower price, then in a free market wages will tend to fall.

[…] This shows the outcome of Scott’s “game of musical chairs”, which he explained here and also in his EconTalk podcast. (Briefly, the intuition is that when total income available to […]

Leave a Reply

Name (required)

Mail (will not be published) (required)

Website

Search

About

Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.